Breaking Down Your Maos: Tax Filing for US Expats & the IRS (Part 3)

In Part One, we looked at the rules US expatriates have to follow when filing their taxes. In Part Two, we then looked at the specific process of filing the most common forms which need to be completed. In the third and final installment of our series, we will take a look at what to do with the dollars you have left over after you have filed.

As we have discussed in the previous posts, the first USD 100,800 of foreign income qualifies for the Foreign Earned Income Exemption (FEIE), subject to you meeting the foreign resident test. This is a significant deduction and will generally mean that a US expatriate has little or no US Income Tax liability. Even if you do not qualify for the FEIE, then you most likely still have the ability to claim a tax credit under the tax treaty between the US and China.

In the US, contributions to qualified retirement plans, such as IRAs and 401Ks, can be made pre-tax and therefore reduce your taxable income. For some US expatriates there may be no US Income Tax from which to deduct. Unfortunately, this means that many US expatriates I meet decide to stop making contributions altogether. It should be obvious to everyone that putting financial planning for your future on hold while you live and work abroad is not a good idea. Regardless of whether there is any deduction to be made from your taxable income, you will still benefit from making these contributions and should not stop.

US expatriates can still contribute to an IRA up to the annual maximum of USD 5,500, or USD 6,500 if over the age of 50. Even if they do not receive the income tax deduction, the account still provides tax-free accumulation and has no annual reporting requirement. Furthermore, US expatriates can establish their own 401K and Defined Benefit plans while they live and work offshore. This will allow them to contribute up to USD 210,000 on an annual basis and again receive tax-free accumulation, with no annual reporting requirement.

What some people choose to do is to invest in off-shore schemes and insurance plans. These plans offer no benefits for US taxpayers due to an annual reporting requirement in the US, which can be very complex because these products do not produce IRS compliant documents such as 1099s. Once they are reported, they will often be subject to higher taxes because they qualify as Passive Foreign Investment Companies (PFICs) and may have Excess Distribution Rules applied to them. By comparison, all US investment accounts have tax advantages for US citizens and are much easier to report on an annual basis.

To recap:
1. Do not stop saving just because you lose the ability to save on a pre-tax basis.
2. Back in the US your tax treatment is better and reporting requirements are easier.

Other than the aforementioned qualified accounts, such as 401Ks and IRAs, what other investment opportunities are available where it is possible to take tax advantages?

Life Insurance – There are many different types of life insurance policy. Certain policies will allow you to accumulate a cash value that you can redeem later in life. Any growth achieved inside the policy is tax free and non-reportable. Furthermore, the better of these investments will allow you to grow your money in market-based products, such as the S&P 500, which deliver equity style returns. Such plans offer the opportunity of taking tax-free withdrawals, providing an income through your retirement.

Annuities – These are treated as qualified retirement accounts; they carry tax-free accumulation with no annual reporting requirement. Some policies provide guaranteed returns with no market risk. This is ideal for the more cautious investor as this type of policy can produce good returns with the guarantee that the balance will never go down in value. There are annuities of varying quality; this style of investment is complex and would warrant an article in itself. It is important to get sound, professional advice before choosing this option.

Brokerage accounts – A few select investment providers in the US still have an appetite for overseas business. Charles Schwab and Pershing Bank are two of the market leaders in offering accounts for expatriates. These investment platforms can hold qualified accounts inside them, as well as non-qualified, after-tax savings money. Such accounts allow the client access to a limitless investment range, giving the account holder the ability to buy and hold some of the best investment funds in the market place.

A recent study by Vanguard, one of the largest IRA providers in the US, found that the average account of the IRAs under their management was approximately USD 200,000. When I plan retirement incomes, I work on being able draw down 5 percent of a retirement fund on an annual basis. This would provide an annual retirement income of USD 10,000 to the average Vanguard client.

The days of employers and governments supporting individuals through retirement are coming to an end. We are now on our own and have to make provision to take care of ourselves. Wherever you work in the world, make sure you are making the most of your after-tax dollars.Please note that beijingkids does not necessarily endorse the views presented in this article.

About William Frisby

William originally arrived in Beijing as a finance guy on a bicycle and will probably leave as a finance guy on a bicycle. He works for Premium Finance Group (PFG), a financial consultancy that has been established in China for over ten years. PFG offers clients no-nonsense, personalized advice and serves the whole of China from their Beijing and Shanghai offices. Services include international property, investment, insurance and financial planning. To contact William, email william.frisby@premiumfinance-group.com.